The credit default swap (CDS) market has gained in importance and popularity by being adapted to the sophisticated hedging and investment strategies of investors acting in the credit market. The development of sound and flexible models that can be easily calibrated to market data and that can allow the valuation of the growing family of CDS derivatives has never been as important and timely as it is in the current market environment. This paper responds to these needs by providing an arbitrage-free tree approach of dynamic mean-reverting leverage that allows perfect matching of the market CDS curve while also offering robust calibration to market volatility data. The proposed CDS-tree model simplifies and unifies the valuation of both plain-vanilla and complex CDS derivatives, including European-style options, Bermudan CDS options and constant maturity CDSs.

P>This article proposes a model that suggests there are contagion effects among members of an insurance guaranty fund when postassessments are charged to all other insurers upon the failure of a member company. Indeed, these extraordinary payments are shown to increase the default rate of other firms in the industry, ultimately lowering the value of corporate claims as well as government tax claims. The model is also used to examine the efficiency of different recoupment mechanisms (both existing and new) used by regulators and insurers to potentially reduce these contagion effects. Analysis allows us to stipulate the conditions under which a "tax carryforward" provision could be more efficient than the usual recoupment mechanisms known as "premium rate surcharge" and "premium tax credit.".

This paper reviews the last 30 years of efforts to model mutual financial intermediaries and to distinguish them from the more "traditional" models of joint-stock commercial banks. The authors reviewed here have attempted to articulate, in a formal fashion, conflicts of interest between participants in the process that oppose the bundle of contracts that constitutes this form of firms. We focus on the conflicts of interest between "net borrower" and "net saver" members, and on the conflict between members and managers of the mutual.

Top-down’ approach of portfolio credit risk lacks of transparency in terms of explicit implications at the ‘down’ level. ‘Bottom-up’ approach is less flexible to accommodate for modeling the dynamics of credit loss. In this paper, a hybrid approach is proposed, which combines both the modeling parsimony of ‘top-down’ models and the explicit implications of ‘bottom-up’ models in terms of default risk of single names. Correlated forward credit losses of the n constituents of the pool (or index) are modeled under a HJM-like framework. This allows for arbitrage-free dynamics of single names’ defaults matching the n single names’ CDS spread curves and an explicit characterization of a name-sensitive credit loss correlation structure. Under an explicit setup of correlated lognormal cumulated credit losses, it is argued that the Inverse-Gamma distribution (with time-varying shape and scaling parameters generated back at the ‘down’ level by the HJM-like model) approximates the credit pool loss distribution, which results in a simple closed-form solution of CDO spreads. Calibration is made efficiently thanks to a name grouping technique and shows a high fitting power of the model, particularly for the skew of the market CDO spreads. Calibration procedure, model extensions and numerical examples illustrating the impact of the subprime crisis are discussed. Furthermore, Monte Carlo methods for the simulation of the Inverse-Gamma pool loss dynamics are developed to price CDO derivatives with early-exercise-style and/or losstrigger features. JEL classifications: G13.

This paper presents a model of network formation for credit mutuals (CM). The importance of the subject resides in the fact that CM as well as many other types of mutual organizations tend often to integrate into network-like struc- tures. Sometimes these structures are so imposing that they have become, when taken as a network, the primary, or one of the primary, financial institutions in the country. However, little is known about the factors that influence their formation and stability. We present the model in three steps. First we develop a simple model of a CM that maximizes member monetary and non-monetary surplus. Then we define the basic structure of a network that separates it from a conglomerate with subsidiaries, and, based on that definition, build a model of a network by assuming absence of default. This basic model allows us to draw a number of predictions about the factors that influence the formation of network. Amongst the more interesting ones we may cite that operational effi- ciency is not the (only) reason for networks to be desirable. Other factors, such as diversifying the mixture of membership (savers vs. borrower members) may also have an influence. Further, members may draw benefits from networking from benefiting from additional monetary and non-monetary surpluses. In the

We investigate whether rating agencies calibrate the rating of bonds issued by cooperative banks and stock banks to the true risk of insolvency of the issues. Agency theoretic arguments suggest that cooperative banks are subject to incentives to hold asset portfolios of lower risk than a stock bank. This difference should be reflected, on average, in a higher quality rating for cooperative banks bonds over stock banks bonds. To perform the empirical analysis we use as benchmark of ex-ante market wide estimate of insolvency risk, the yield spread required by the investors on bonds of both types of institutions. The hypothesis is that if investors require a lower insolvency risk premia on bonds, this should be reflected in a higher-quality rating. Alternatively, if investors require systematically a lower premia on cooperative bank bond issues than comparable issues of comparable stock banks after controlling for the rating, this means that investors perceive that the institution presents a lower insolvency risk than that implied by the rating. We use 106 pairs of a matched samples of cooperative and stock banks to perform the analysis. The results obtained are that, after controlling for other sources of variation in the risk premia (including rating), investors charge a lower and statistically significant spread on cooperative banks than on stock banks. However, rating agencies make no difference in the rating and thus ignoring the ex-ante lower insolvency risk in their assessment. Further, results suggest that rating agencies may not have a clear model for rating CB bonds consistently. This findings agree with similar results in the literature that find that rating agencies display a bias toward known management styles and favor (commercial) banks over other (industrial) type of enterprises.